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“How Well Am I Doing?” Statement of Cash Flows. Chapter Fifteen. Purpose of the Statement of Cash Flows. Why is there a difference between net income and net cash flow?. Are cash flows sufficient to support ongoing operations?. Can we meet our obligations to creditors?. - PowerPoint PPT Presentation
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Copyright © 2008, The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin
Chapter Fifteen
“How Well Am I Doing?”Statement of Cash Flows
Copyright © 2008, The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin
15-2
Purpose of the Statement of Cash Flows
Are cash flows sufficient to
support ongoing operations?
Are cash flows sufficient to
support ongoing operations? Can we meet
our obligations to creditors?
Can we meet our obligations
to creditors?
Can we pay dividends?
Can we pay dividends?
Why is there a difference
between net income and net
cash flow?
Why is there a difference
between net income and net
cash flow?
Will the company have to borrow money to make
needed investments?
Will the company have to borrow money to make
needed investments?
Copyright © 2008, The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin
15-3
Learning Objective 1
Classify changes in Classify changes in noncash balance noncash balance sheet accounts as sheet accounts as sources or uses of sources or uses of
cash.cash.
Copyright © 2008, The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin
15-4
Cash
The term cash on the statement of cash flows refers broadly to both currency and
cash equivalents.
Cash
T-bills
Money Market Funds
Commercial Paper
Currency and Bank Accounts
Copyright © 2008, The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin
15-5
Net Cash Flows for a
Period
Net Cash Flows for a
Period
Net IncomeNet Income
Dividends Paid to
Stockholders
Dividends Paid to
Stockholders
Changes in Noncash Assets
Changes in Noncash Assets
Changes in Liabilities
Changes in Liabilities
Changes in Capital StockChanges in
Capital Stock
Constructing the Statement of Cash Flows Using Changes in Noncash Balance Sheet Accounts
Copyright © 2008, The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin
15-6
Constructing the Statement of Cash Flows Using Changes in Noncash Balance Sheet Accounts
Copyright © 2008, The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin
15-7
Constructing the Statement of Cash Flows Using Changes in Noncash Balance Sheet Accounts
Example: Inventory is purchased on credit from
a supplier.
Example: Inventory is purchased on credit from
a supplier.
It is implied that cash was used to acquire the
inventory.
Increases in noncash assetnoncash asset accounts imply usesuses of cash.
Copyright © 2008, The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin
15-8
Constructing the Statement of Cash Flows Using Changes in Noncash Balance Sheet Accounts
It is implied that an increase in a payable has the effect
of increasing cash available for other uses.
Increases in liabilityliability accounts imply sourcessources of cash.
Example: Inventory is purchased on credit from
a supplier.
Example: Inventory is purchased on credit from
a supplier.
Copyright © 2008, The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin
15-9
Constructing the Statement of Cash Flows Using Changes in Noncash Balance Sheet Accounts
Decreases in noncash assetsnoncash assets accounts imply sourcessources of cash.
Example: Accounts receivable decreases when a company
pays its bill.
Example: Accounts receivable decreases when a company
pays its bill.
When the customer pays the bill, the company’s cash
increases.
Copyright © 2008, The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin
15-10
Constructing the Statement of Cash Flows Using Changes in Noncash Balance Sheet Accounts
Decreases in liabilityliability accounts imply usesuses of cash.
When the payment is made, cash decreases.
Example: A company pays a note payable held
by a creditor.
Example: A company pays a note payable held
by a creditor.
Copyright © 2008, The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin
15-11
A Simplified Statement of Cash Flows: An Example
Ed's Pizza HutComparative Balance Sheet Account Balances
3/31/2008 3/31/2007 ChangeDR (CR) DR (CR) Incr. (Decr.)
Cash 71,000$ 90,000$ (19,000)$ Accounts Receivable 23,000 40,000 (17,000) Inventory 350,000 300,000 50,000 Land 68,000 100,000 (32,000) Equipment 84,000 84,000 - Accumulated Depr. (45,000) (39,000) 6,000 Accounts Payable (38,000) (27,000) 11,000 Salaries Payable (9,000) (14,000) (5,000) Note Payable - Joe Doe - (50,000) (50,000) Common Stock (500,000) (450,000) 50,000 Retained Earnings (4,000) (34,000) (30,000)
-$ -$
Copyright © 2008, The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin
15-12
Additional Information: There was a net loss for the year of $27,000. Depreciation charges for the year were $6,000. During the year, Ed sold land originally costing
$32,000 for $32,000. During the year, Ed paid dividends of $3,000 to the
stockholders. Ed issued $50,000 of common stock to settle the
note due to Joe Doe.
Additional Information: There was a net loss for the year of $27,000. Depreciation charges for the year were $6,000. During the year, Ed sold land originally costing
$32,000 for $32,000. During the year, Ed paid dividends of $3,000 to the
stockholders. Ed issued $50,000 of common stock to settle the
note due to Joe Doe.
A Simplified Statement of Cash Flows: An Example
Copyright © 2008, The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin
15-13
A Simplified Statement of Cash Flows: An Example
Decrease in A/R 17,000$ Decrease in Land 32,000 Increase in A/P 11,000 Depreciation charges 6,000 Total sources of cash 66,000$
Ed's Pizza HutSources of Cash
Here is a summary of the sources of cash for Ed’s Pizza Hut.
Copyright © 2008, The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin
15-14
A Simplified Statement of Cash Flows: An Example
Here is a summary of the uses of cash for Ed’s Pizza Hut.
Net loss 27,000$ Increase in Inventory 50,000 Increase in Salaries Payable 5,000 Dividends paid 3,000 Total uses of cash 85,000$
Ed's Pizza HutUses of Cash
The net cash flow for Ed’s Pizza Hut is ($19,000): $66,000 in sources minus $85,000 in uses.
Copyright © 2008, The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin
15-15
A Simplified Statement of Cash Flows
Decrease in A/R 17,000$ Decrease in Land 32,000 Increase in A/P 11,000 Depreciation charges 6,000 Total sources of cash 66,000$
Ed's Pizza HutSources of Cash
Net loss 27,000$ Increase in Inventory 50,000 Increase in Salaries Payable 5,000 Dividends paid 3,000 Total uses of cash 85,000$
Ed's Pizza HutUses of Cash
This simplified approach does not follow the
format required for external reporting
purposes. It is for illustrative purposes only.
Copyright © 2008, The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin
15-16
Learning Objective 2
Classify transactions Classify transactions as operating, as operating, investing, or investing, or
financing activities.financing activities.
Copyright © 2008, The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin
15-17 The Full-Fledged Statement of Cash Flows: Operating Activities
Operating activities are those activities that enter into the determination of
net income.
Transactions affecting current
assets
Transactions affecting current
liabilities
Changes in noncurrent
balance sheet accounts that
directly affect net income
Copyright © 2008, The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin
15-18 The Full-Fledged Statement of Cash Flows: Investing Activities
Investing activities relate to transactions involving the acquiring or disposing of
noncurrent assets.
Acquiring or selling property,
plant and equipment
Acquiring or selling securities
Lending money to another entity and
subsequently collecting on the
loan
Copyright © 2008, The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin
15-19 The Full-Fledged Statement of Cash Flows: Financing Activities
Financing activities relate to transactions involving borrowing
from creditors or repaying creditors and engaging in
transactions with the company’s owners.
Issuing stock and purchasing
treasury stock
Payment of dividends (note that interest on
debt is classified as an operating
activity)Issuing long-term debt and
repayment of debt.
Copyright © 2008, The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin
15-20The Full-Fledged Statement of Cash Flows: An Overview
Operating Activities:Net incomeChanges in current assetsChanges in noncurrent assets that affect net income (e.g., depreciation)Changes in current liabilities (except for debts to lenders and dividends payable)Changes in noncurrent liabilities that affect net income
Investing Activities:Changes in noncurrent assets that are not included in net income
Financing Activities:Changes in the current liabilities that are debts to lenders rather than obligations to suppliers, employees, or the governmentChanges in noncurrent liabilities that are not included in net incomeChanges in capital stock accountsDividends
Copyright © 2008, The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin
15-21The Full-Fledged Statement of Cash Flows: An Overview
Operating Activities
Investing Activities
Financing Activities
Reconciliation of the beginning cash balance
with the ending cash balance
Noncash Investing and Financing
Activities
Copyright © 2008, The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin
15-22
Operating Activities
Includes those activities that enter into the determination of net income.
Includes those activities that enter into the determination of net income.
Copyright © 2008, The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin
15-23
Operating Activities
Sources of cash are added to net income and uses of cash are subtracted from net income.
Sources of cash are added to net income and uses of cash are subtracted from net income.
Copyright © 2008, The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin
15-24
Operating Activities
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15-25
Operating Activities
Copyright © 2008, The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin
15-26
Depreciation and Amortization charges are added back to net income because they are decreases in
noncash assets.
Depreciation and Amortization charges are added back to net income because they are decreases in
noncash assets.
Operating Activities
Copyright © 2008, The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin
15-27
Losses are added back to net income.
Losses are added back to net income.
Operating Activities
Gains are subtracted from net
income.
Gains are subtracted from net
income.
Copyright © 2008, The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin
15-28
Add: Proceeds from sale of land, buildings, equipment, or other noncurrent assets $ XXX Receipt of principal from investments XXX
Less: Payments to acquire land, buildings, equipment, or other noncurrent assets (XXX)Payments to acquire investments (XXX)
Net Cash Flows from Investing Activities $ XXX
Add: Proceeds from sale of land, buildings, equipment, or other noncurrent assets $ XXX Receipt of principal from investments XXX
Less: Payments to acquire land, buildings, equipment, or other noncurrent assets (XXX)Payments to acquire investments (XXX)
Net Cash Flows from Investing Activities $ XXX
Includes transactions that involve the acquisition or disposal of noncurrent assets.
Includes transactions that involve the acquisition or disposal of noncurrent assets.
Investing Activities
Copyright © 2008, The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin
15-29
Add: Proceeds from borrowings $ XXX Proceeds from issuing capital stock XXX Proceeds from sale of bonds XXX
Less: Principal payments on borrowed funds (XXX)Payments related to bond maturities (XXX)Dividend payments (XXX)
Net Cash Flows from Financing Activities $ XXX
Add: Proceeds from borrowings $ XXX Proceeds from issuing capital stock XXX Proceeds from sale of bonds XXX
Less: Principal payments on borrowed funds (XXX)Payments related to bond maturities (XXX)Dividend payments (XXX)
Net Cash Flows from Financing Activities $ XXX
Includes transactions involving receipts from or payments to creditors and owners.
Includes transactions involving receipts from or payments to creditors and owners.
Financing Activities
Copyright © 2008, The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin
15-30
Other Issues: Gross or Net?
For investing and financing
activities, items on the statement of
cash flows should be presented in gross amounts
rather than in net amounts.
Example: Assume Macy’s
purchases $50 million in property during the year and sells other property for $30 million.
Instead of showing the net change of $20 million, the company must report the gross amounts of both transactions.
Example: Assume Macy’s
purchases $50 million in property during the year and sells other property for $30 million.
Instead of showing the net change of $20 million, the company must report the gross amounts of both transactions.
Copyright © 2008, The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin
15-31
Other Issues: Direct Method or Indirect Method?
Two Formats for Reporting Operating Activities
Reports the cash effects of each operating
activity
Starts with accrual net income and converts to cash basis
Direct Method Indirect Method
No matter which format is used, the same amount of net cash flows from operating activities is generated.
Copyright © 2008, The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin
15-32
Learning Objective 3
Prepare a statement Prepare a statement of cash flows using of cash flows using
the indirect method to the indirect method to determine the net determine the net cash provided by cash provided by
operating activities.operating activities.
Copyright © 2008, The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin
15-33 A Full-Fledged Statement of Cash Flows: An Example
Let’s revisit the comparative
balance sheet account balances for Ed’s Pizza Hut.
Ed's Pizza HutComparative Balance Sheet Account Balances
3/31/2008 3/31/2007 ChangeDR (CR) DR (CR) Incr. (Decr.)
Cash 71,000$ 90,000$ (19,000)$ Accounts Receivable 23,000 40,000 (17,000) Inventory 350,000 300,000 50,000 Land 68,000 100,000 (32,000) Equipment 84,000 84,000 - Accumulated Depr. (45,000) (39,000) 6,000 Accounts Payable (38,000) (27,000) 11,000 Salaries Payable (9,000) (14,000) (5,000) Note Payable - Joe Doe - (50,000) (50,000) Common Stock (500,000) (450,000) 50,000 Retained Earnings (4,000) (34,000) (30,000)
-$ -$
Copyright © 2008, The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin
15-34 A Full-Fledged Statement of Cash Flows: An Example
Additional Information: There was a net loss for the year of $27,000. Depreciation charges for the year were $6,000. During the year, Ed sold land originally costing
$32,000 for $32,000. During the year, Ed paid dividends of $3,000 to
the stockholders. Ed issued $50,000 of common stock to settle the
note due to Joe Doe.
Additional Information: There was a net loss for the year of $27,000. Depreciation charges for the year were $6,000. During the year, Ed sold land originally costing
$32,000 for $32,000. During the year, Ed paid dividends of $3,000 to
the stockholders. Ed issued $50,000 of common stock to settle the
note due to Joe Doe.
Let’s also refresh our memory regarding the following additional information.
Copyright © 2008, The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin
15-35
ChangeSource or Use?
Cash Flow Effect
Adjust-ments
Adjusted Effect
Classifi- cation
Accounts receivableInventory
LandEquipment
Accumulated depreciation
Accounts payableSalaries payable
Notes payable
Common stock
Net lossDividends
Total (net cash flow)
Retained earnings
Ed's Pizza HutStatement of Cash Flows Worksheet
Noncurrent liabilities
Stockholders' equity
Current liabilities
Assets (except cash and Current assets
Noncurrent assets
Contra Assets, Liabilities, Contra assets
Preparing the Statement of Cash Flows: Step 1
List each account appearing on the
comparative balance sheets except for cash and cash equivalents
and retained earnings.
Copyright © 2008, The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin
15-36
ChangeSource or Use?
Cash Flow Effect
Adjust-ments
Adjusted Effect
Classifi- cation
Accounts receivable (17,000)$ Inventory 50,000
Land (32,000) Equipment -
Accumulated depreciation 6,000
Accounts payable 11,000 Salaries payable (5,000)
Notes payable (50,000)
Common stock 50,000
Net loss (27,000) Dividends 3,000
Ed's Pizza HutStatement of Cash Flows Worksheet
Noncurrent liabilities
Stockholders' equity
Current liabilities
Assets (except cash and Current assets
Noncurrent assets
Contra Assets, Liabilities, Contra assets
Total (net cash flow)
Retained earnings
Preparing the Statement of Cash Flows: Step 2
Compute the change from the beginning
balance to the ending balance for each
account.
Copyright © 2008, The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin
15-37
ChangeSource or Use?
Cash Flow Effect
Adjust-ments
Adjusted Effect
Classifi- cation
Accounts receivable (17,000)$ SourceInventory 50,000 Use
Land (32,000) SourceEquipment -
Accumulated depreciation 6,000 Source
Accounts payable 11,000 SourceSalaries payable (5,000) Use
Notes payable (50,000) Use
Common stock 50,000 Source
Net loss (27,000) UseDividends 3,000 Use
Contra Assets, Liabilities, Contra assets
Total (net cash flow)
Retained earnings
Ed's Pizza HutStatement of Cash Flows Worksheet
Noncurrent liabilities
Stockholders' equity
Current liabilities
Assets (except cash and Current assets
Noncurrent assets
Preparing the Statement of Cash Flows: Step 3
Code each entry on the worksheet as a
source or use of cash.
Recall that the transaction involving the Notes Payable and
Common Stock was noncash.{
Copyright © 2008, The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin
15-38
ChangeSource or Use?
Cash Flow Effect
Adjust-ments
Adjusted Effect
Classifi- cation
Accounts receivable (17,000)$ Source 17,000$ Inventory 50,000 Use (50,000)
Land (32,000) Source 32,000 Equipment - -
Accumulated depreciation 6,000 Source 6,000
Accounts payable 11,000 Source 11,000 Salaries payable (5,000) Use (5,000)
Notes payable (50,000) Use (50,000)
Common stock 50,000 Source 50,000
Net loss (27,000) Use (27,000) Dividends 3,000 Use (3,000)
(19,000)$ Total (net cash flow)
Retained earnings
Ed's Pizza HutStatement of Cash Flows Worksheet
Noncurrent liabilities
Stockholders' equity
Current liabilities
Assets (except cash and Current assets
Noncurrent assets
Contra Assets, Liabilities, Contra assets
Preparing the Statement of Cash Flows: Step 4
Code sources of cash as
positive numbers and uses of cash as negative numbers.
Copyright © 2008, The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin
15-39
ChangeSource or Use?
Cash Flow Effect
Adjust-ments
Adjusted Effect
Classifi- cation
Accounts receivable (17,000)$ Source 17,000$ - 17,000$ Inventory 50,000 Use (50,000) - (50,000)
Land (32,000) Source 32,000 - 32,000 Equipment - - - -
Accumulated depreciation 6,000 Source 6,000 - 6,000
Accounts payable 11,000 Source 11,000 - 11,000 Salaries payable (5,000) Use (5,000) - (5,000)
Notes payable (50,000) Use (50,000) 50,000 -
Common stock 50,000 Source 50,000 (50,000) -
Net loss (27,000) Use (27,000) - (27,000) Dividends 3,000 Use (3,000) - (3,000)
(19,000)$ -$ (19,000)$
Ed's Pizza HutStatement of Cash Flows Worksheet
Noncurrent liabilities
Stockholders' equity
Current liabilities
Assets (except cash and Current assets
Noncurrent assets
Contra Assets, Liabilities, Contra assets
Total (net cash flow)
Retained earnings
Preparing the Statement of Cash Flows: Step 5
Make any necessary
adjustments, including
adjustments for gains and losses. The net effect of these should equal zero.
We need to make an adjustment for the noncash transaction
relating to Notes Payable and Common Stock.
{
Copyright © 2008, The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin
15-40
Preparing the Statement of Cash Flows: Step 6
ChangeSource or Use?
Cash Flow Effect
Adjust-ments
Adjusted Effect
Classifi- cation
Accounts receivable (17,000)$ Source 17,000$ - 17,000$ OperatingInventory 50,000 Use (50,000) - (50,000) Operating
Land (32,000) Source 32,000 - 32,000 InvestingEquipment - - - -
Accumulated depreciation 6,000 Source 6,000 - 6,000 Operating
Accounts payable 11,000 Source 11,000 - 11,000 OperatingSalaries payable (5,000) Use (5,000) - (5,000) Operating
Notes payable (50,000) Use (50,000) 50,000 -
Common stock 50,000 Source 50,000 (50,000) -
Net loss (27,000) Use (27,000) - (27,000) OperatingDividends 3,000 Use (3,000) - (3,000) Financing
(19,000)$ -$ (19,000)$
Contra Assets, Liabilities, Contra assets
Total (net cash flow)
Retained earnings
Ed's Pizza HutStatement of Cash Flows Worksheet
Noncurrent liabilities
Stockholders' equity
Current liabilities
Assets (except cash and Current assets
Noncurrent assets Classify each
entry as operating, investing
or financing activity.
Copyright © 2008, The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin
15-41 Preparing the Statement of Cash Flows: Step 7
Operating ActivitiesNet Loss (27,000)$ Add: Decrease in A/R 17,000
Increase in A/P 11,000 Increase in Depr. Charges 6,000
Less: Increase in Inventory (50,000) Decrease in Salaries Payable (5,000)
Net Cash Flow from Operations (48,000) Investing Activities
Proceeds from sale of Land 32,000 Financing Activities
Dividends paid (3,000) Net change in cash (19,000)
Ed's Pizza HutStatement of Cash Flows
For the Period Ending 3/31/2008
Copy the data from the worksheet into the Statement of
Cash Flows section by section.
Copyright © 2008, The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin
15-42 Preparing the Statement of Cash Flows: Step 8
Operating ActivitiesNet Loss (27,000)$ Add: Decrease in A/R 17,000
Increase in A/P 11,000 Increase in Depr. Charges 6,000
Less: Increase in Inventory (50,000) Decrease in Salaries Payable (5,000)
Net Cash Flow from Operations (48,000) Investing Activities
Proceeds from sale of Land 32,000 Financing Activities
Dividends paid (3,000) Net change in cash (19,000) Cash, beginning 90,000 Cash, ending 71,000$
Ed's Pizza HutStatement of Cash Flows
For the Period Ending 3/31/2008
Prepare a cash reconciliation at the
bottom of the statement.
Copyright © 2008, The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin
15-43
In addition, on the face of the statement or in a supplemental schedule, disclose
the issuance of $50,000 of stock to a creditor, a noncash financing activity.
In addition, on the face of the statement or in a supplemental schedule, disclose
the issuance of $50,000 of stock to a creditor, a noncash financing activity.
Example – Indirect Method
Operating ActivitiesNet Loss (27,000)$ Add: Decrease in A/R 17,000
Increase in A/P 11,000 Increase in Depr. Charges 6,000
Less: Increase in Inventory (50,000) Decrease in Salaries Payable (5,000)
Net Cash Flow from Operations (48,000) Investing Activities
Proceeds from sale of Land 32,000 Financing Activities
Dividends paid (3,000) Net change in cash (19,000) Cash, beginning 90,000 Cash, ending 71,000$
Ed's Pizza HutStatement of Cash Flows
For the Period Ending 3/31/2008
Copyright © 2008, The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin
15-44
Interpretation of the Statement of Cash Flows
Examine the operating activities section carefully.
Ed’s Pizza Hut generated a negative cash flow from operations of $48,000. This is usually a sign of fundamental difficulties.
Ultimately, a positive cash flow is necessary to avoid liquidating assets or borrowing money to pay for day-to-day activities.
Examine the operating activities section carefully.
Ed’s Pizza Hut generated a negative cash flow from operations of $48,000. This is usually a sign of fundamental difficulties.
Ultimately, a positive cash flow is necessary to avoid liquidating assets or borrowing money to pay for day-to-day activities.
Copyright © 2008, The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin
The Direct Method of Determining the Net Cash
Provided by Operating Activities
Appendix 15A
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15-46
Learning Objective 4
Use the direct method Use the direct method to determine the net to determine the net
cash provided by cash provided by operating activities. operating activities.
(Appendix 15A)(Appendix 15A)
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15-47 Computing Net Cash Provided by Operating Activities
The direct method computes net cash provided by operating activities by reconstructing the
income statement on a cash basis from top to bottom.
Cash provided by operating activities under the direct method will always
agree with the amount computed using the indirect method.
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15-48
Similarities and Differences in Handling DataAdd (+) or
Deduct (-) to Adjust to a Cash Basis
Sales revenue (as reported)
Increases in accounts receivable -Decreases in accounts receivable +
Cost of goods sold (as reported)
Increase in merchandise inventory +Decrease in merchandise inventory -Increase in accounts payable -Decrease in accounts payable +
Operating expenses (as reported)
Increase in prepaid expenses +Decrease in prepaid expenses -Increase in accrued liabilities -Decrease in accrued liabilities +Period's depreciation, depletion and amortization charges
-
Income tax expense (as reported)
Increase in accrued taxes payable -Decrease in accrued taxes payable +Increase in deferred income taxes -Decrease in deferred income taxes +
Adjustments to a cash basis:
Revenue or Expense Item
Adjustments to a cash basis:
Adjustments to a cash basis:
Adjustments to a cash basis:
Adjustments for accounts that affect revenue are the
same in the direct and indirect methods.
Adjustments for accounts that affect expenses are
handled in opposite ways for the direct and indirect
methods.
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15-49
Direct Method: Gains and Losses
Under the direct method, no adjustments for gains and losses on the sale of
assets are needed.
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15-50
The Direct Method: An Example
Let’s revisit the comparative
balance sheet account balances for Ed’s Pizza Hut.
Ed's Pizza HutComparative Balance Sheet Account Balances
3/31/2008 3/31/2007 ChangeDR (CR) DR (CR) Incr. (Decr.)
Cash 71,000$ 90,000$ (19,000)$ Accounts Receivable 23,000 40,000 (17,000) Inventory 350,000 300,000 50,000 Land 68,000 100,000 (32,000) Equipment 84,000 84,000 - Accumulated Depr. (45,000) (39,000) 6,000 Accounts Payable (38,000) (27,000) 11,000 Salaries Payable (9,000) (14,000) (5,000) Note Payable - Joe Doe - (50,000) (50,000) Common Stock (500,000) (450,000) 50,000 Retained Earnings (4,000) (34,000) (30,000)
-$ -$
Copyright © 2008, The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin
15-51
The Direct Method: An Example
Sales 1,000,000$ Cost of goods sold 750,000 Gross margin 250,000 Operating expenses 277,000 Net loss (27,000)$
Ed's Pizza HutIncome Statement
For the Year Ended 3/31/2008
Let’s assume that Ed’s Pizza Hut prepared this income statement.
Copyright © 2008, The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin
15-52
The Direct Method: An Example
Step 1: Translate sales revenue into cash
collected from customers.Sales (as reported) 1,000,000$ Add: Decrease in accounts receivable 17,000 Cash collected from customers 1,017,000$
Copyright © 2008, The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin
15-53
The Direct Method: An Example
Step 2: Translate cost of goods sold into cash disbursements for purchases.
Cost of goods sold (as reported) 750,000$ Add: Increase in inventory 50,000 Less: Increase in accounts payable (11,000) Cash paid for purchases 789,000$
Copyright © 2008, The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin
15-54
The Direct Method: An Example
Step 3: Translate operating expenses into cash paid for operating expenses.
Operating expenses (as reported) 277,000$ Add: Decrease in salaries payable 5,000 Less: Increase in depreciation (6,000) Cash paid for operating expenses 276,000$
No adjustment for income taxes is required because Ed’s Pizza Hut has a net
loss of $27,000.
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The Direct Method: An Example
Operating ActivitiesCash received from customers 1,017,000$ Cash paid for purchases (789,000) Cash paid for operating expenses (276,000) Net Cash Flow from Operations (48,000) Investing Activities
Proceeds from sale of land 32,000 Financing Activities
Dividends paid (3,000) Net change in cash (19,000) Cash, beginning 90,000 Cash, ending 71,000$
Ed's Pizza HutStatement of Cash Flows
For the Period Ending 3/31/2008Notice that the
net cash provided by
operating activities agrees
with that computed using
the indirect method.
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End of Chapter 15